United States: Disclosing Corporate Governance Information Under the New Executive Compensation Regulations

For the past few years, issuers have been required to disclose in filings with the SEC certain information regarding director independence and other corporate governance matters. The commission has recently consolidated these requirements under a new Item 407 of Regulation S-K.¹

Registrants must disclose information about director independence, nominating, audit and compensation committees, and shareholder communications by:

• Identifying each independent director of the company (and the nominees for director when the information is being presented in a proxy or information statements) as measured by the company’s definition of independence;

• Identifying any members of the compensation, nominating, and audit committee whom the company has not identified as independent under such definition;

• Describing, by specific category or type, any related party transactions, relationships, or arrangements not disclosed pursuant to Item 404 that were part of the board of directors’ consideration in determining that the independence standard has been met as to each independent director or director nominee.

• Providing the number of board meetings during the fiscal year and certain attendance information, including the board’s policy on attendance at annual shareholder meetings and attendance information with respect to the last annual meeting;

• Identifying any standing audit, nominating, and compensation committees, the membership composition, and the number of meetings, together with certain descriptive information regarding such committees and their charters (see "compensation committee disclosure" discussion below);² and

• Disclosing information about the audit committee’s independence and expertise, and about the process for shareholders to send communications to the registrant’s board of directors. If there is no process, the basis for the board’s view that it is appropriate not to have such a process and, if all shareholder communications are not sent directly to board members, a description of the process for determining which communications will be provided to board members.

For the first time, SEC regulations call for disclosures with respect to the compensation committee similar to that required for the audit and nominating committees of the board. Now required is a description of the processes and procedures for the consideration and determination of executive and director compensation including:

• The scope of authority of the compensation committee and the extent to which the compensation committee may delegate any authority to other persons, specifying what authority may be so delegated and to whom;

• The identification of the committee’s charter or other documentation of its authority, and the company’s Web site address at which a current copy is available, if it is so posted, and if not so posted, attaching the charter to the proxy statement once every three years;

• The identification of any role of executive officers or of compensation consultants in determining or recommending the amount or form of executive and director compensation, identifying such consultants, stating whether such consultants are engaged directly by the compensation committee or any other person, describing the nature and scope of their assignment, and the material elements of the instructions or directions given to the consultants with respect to the performance of their duties under the engagement; and

• The identification of compensation committee interlocks and insider participation in compensation decisions.³

The new rules require the inclusion of a Compensation Committee Report under which the compensation committee of the board of directors is required to disclose whether it has reviewed and discussed the Compensation Discussion and Analysis (now required by Item 402(b) of Regulation S-K) with management, and whether it has recommended to the board of directors the inclusion of the Compensation Discussion and Analysis in the company’s annual report and/or proxy or information statement. The name of each member of the Compensation Committee must appear below this report.

Although this report will be required to be included or incorporated by reference into a company’s annual report on Form 10-K, it will be considered as furnished, not filed, such that it will not be considered soliciting material, will not be part of the proxy statement or part of any other filing in which it is included, and will not be subject to Regulations 14A or 14C and the liability provisions of Section 18 of the Exchange Act. The Compensation Committee Report will not be covered by the chief executive and financial officers’ certifications.

Compliance with the new Item 407 will entail sensitivity to the overlaps with Item 404 and their potential interplay with the independence requirements of the national securities exchanges and inter-dealer quotation systems. New disclosures regarding (i) any committee members who are not identified as independent under a registrant’s definition of independence, or (ii) transactions that were not disclosed under Item 404 but must be disclosed, by category or type, under Item 407 if they were taken into account in assessing director independence, may or will require new or additional analysis and/or refined tracking mechanisms. We believe that the invitations contained in the revised regulations to provide board explanations of the appropriateness of not having standing nominating and compensation committees, or about how unwritten conflict-of-interest policies or procedures are evidenced, should be interpreted as strong encouragement to create the committees and write the policies.

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